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Generating higher prices in a low price market

The groundhog saw it’s shadow last week and it reminded me of the movie Groundhog Day. Similar to the plot of the movie the corn market is repeating itself day after day, week after week and now month after month. No one knows when or what will cause the cycle will end.

Beans, on the other hand, are primarily driven in the short-term by Argentina weather for the next few weeks.

 

Generating higher prices in a low price market

For over half a year the corn market has gone nowhere. Farmers don’t want to sell at low prices, and supply doesn’t warrant end users to pay up for corn. Consequently, prices are stuck at levels farmer dislike. Still, it’s essential for my farm operation to try and sell at higher levels. This has meant considering alternative solutions in my market strategy. And in the past year, I’ve had some success increasing profits by selling options, specifically calls and straddles.

 

What does it mean to sell a call?

This means I’m willing to sell to someone else the right to buy my grain at a specified value. On the day the option expires, if the market is above that value I have to sell my grain. If it’s lower, I don’t sell the grain. In both cases, I keep the premium of the sold call.

 

What does it mean to sell a straddle?

This means selling a call option and a put option at the same value (i.e. strike price). On the option’s expiration date the closer the current market price is to the strike price of the option, the more premium I will receive. The further away from the strike price value, the less value I will receive. While I think straddles provide a great hedging opportunity, there is some risk. If the strike price falls far enough, I may have to buy grain at a price above current market values.

Often analysts dramatize the risk associated with selling options, probably because they look at it from a speculators point of view. I think this is unfortunate because farmers should be aware of all their choices and the consequences of any price direction. Admittedly selling options has some risk, but so does buying options. In my opinion buying options, and specifically corn options, can be far more risky for a farmer than selling those options that the analysts frequently recommend.

I think it’s important to know all of your choices first and then making decisions that one feels comfortable with as the best way to develop a marketing strategy. Following provides another recent example of how selling a call and a straddle help to make my farm operation attain higher prices when prices are generally unprofitable.

The following trades expired on 1/26/18. Following shows my rational for originally placing the trades and the final outcomes.

 

Straddle trade

On 11/16/17 when March corn was $3.49, I made the following trade on 10% of my ’17 production.

  • Sold a February $3.55 straddle, where I sell both the $3.55 put and $3.55 call and collect just over a 17-cent premium.
  • Trade expires1/26/18
  • Potential benefit: If March futures close at $3.55 on 1/26/18, I keep all of the 17 cent premium.
  • Potential concern: Reduced or no premium if the market moves significantly in either direction. For every penny lower than $3.55 I get less premium until $3.38. At $3.38 or lower and I will be losing money on this trade penny for penny. For every penny higher than $3.55 I get less premium until $3.72. At $3.72 or higher I have to make a corn sale at $3.55 against March futures, but I still get to keep the 17 cents so it’s like selling $3.72.

 

Sold call

On 12/1/17 when March corn was near $3.59 I sold the following call:

  • Sold a Feb $3.55 call for 10 cents that expires Jan. 26 on 10% of my ’17 production.
  • If corn is trading below the strike price when this option expires I keep the 10-cent premium and add it to another trade later.
  • If corn is trading above the strike price when this option expires I have to sell corn for the strike price PLUS I keep the premium, which means, I will have a price of $3.65 on the trade ($3.55 + 10 cents option premium).

 

What happened?

On 1/25/18, one day before both trades expired, corn was trading at $3.56, so I bought back both sides (both the puts and the calls) of the straddle for 3 cents. This means I made 14 cents in profit on this trade (17-cent sale – 3 cent buy back).

On 1/26/18 corn was still trading at 3.56, so I let the call get exercised and turn into a short futures position of $3.55.

 

Why let the call sale get exercised and not the call in the straddle?

Sold Call: I could have bought back the call, but I’m behind in my ’17 sales and I expect the sideways market to continue. This trade ultimately was better than selling corn originally at $3.59 futures because I receive a sale for $3.55 but I have 10 cents of premium to add so it’s like selling $3.65. Now I’ll take the futures sale from this trade and roll it forward to July and pick up the market carry, which is around another 16 cents of profit. I have yet to actually roll this trade forward so I do have some spread risk.

 

Sold Straddle: I didn’t intend to sell or buy back any grain on the straddle trade when I placed it. While I was OK if either scenario happened, they were just the worst case scenarios. My goal for the straddle was to make as much premium as possible and then add it to a future trade, increasing my sale price levels. I’m very pleased with the outcome of this trade.

I can actually add the straddle premium to my sold call and new futures sale. Following provides the theoretical final value of this trade which represents 10% of my ’17 production:

 

$3.55 Futures Sale

+ .10 Call Premium

+ .14 Straddle Premium

$3.79 Against March Futures

+ .16 Market Carry Potential

$3.95 Potential Final futures Price

 

This trade takes me from around 15% sold on my ’17 crop to nearly 25%. My average sale price is still unknown because of the many options positions open for the ’17 crop.

By selling options I’m able to manufacture corn prices at levels that are much closer to profitable levels, which is mandatory for my farm operation’s future success. While some farmers prefer to wait and hope for prices to go back up in the futures, I’m using the relative “consistency” of the current sideways market to make added profit in the meantime. I’m hoping prices go up too, but what if they don’t?

 

Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.

Trading of futures, options, swaps and other derivatives is risky and is not suitable for all persons. All of these investment products are leveraged, and you can lose more than your initial deposit. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful, and in accordance with applicable laws and regulations in such jurisdiction. The information provided here should not be relied upon as a substitute for independent research before making your investment decisions. Superior Feed Ingredients, LLC is merely providing this information for your general information and the information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision. The contents of this communication and any attachments are for informational purposes only and under no circumstances should they be construed as an offer to buy or sell, or a solicitation to buy or sell any future, option, swap or other derivative. The sources for the information and any opinions in this communication are believed to be reliable, but Superior Feed Ingredients, LLC does not warrant or guarantee the accuracy of such information or opinions. Superior Feed Ingredients, LLC and its principals and employees may take positions different from any positions described in this communication. Past results are not necessarily indicative of future results. He can be contacted at jon@superiorfeed.com.

 

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